The positive CreditWatch implications indicate the likelihood that we will raise Zobele's long-term rating to 'B' with a positive outlook if the bond issuance is successfully completed under the preliminary terms and conditions that we have reviewed. These include amounts and maturity of the bond and the revolving credit facility (RCF), absence of maintenance covenants, and the conversion of the group's entire shareholder loan into equity.
Zobele's 'B-' corporate credit rating is constrained by our view of its "less-than-adequate" liquidity position, and its high debt-to-EBITDA ratio.
Under the current capital structure, we calculate tight--below 10%--headroom under the leverage maintenance covenant of Zobele's syndicated bank debt on Sept. 30, 2012, and we project a likely breach of covenants over the next 12 months without refinancing. This translates into our assessment of the group's liquidity as "less than adequate."
We also calculate a Standard & Poor's adjusted ratio of debt to EBITDA, including the shareholder loan, in excess of 7x, and we anticipate limited deleveraging without refinancing and conversion of the entire shareholder loan into equity due to the payment-in-kind (PIK) characteristics of the shareholder loan. This translates into our assessment of Zobele's financial profile as "highly leveraged."
We view Zobele's business risk profile as "weak," reflecting its fairly small scale of operations and bargaining power with its customers, mostly large household and personal care companies. In our opinion, Zobele is highly reliant on its top four customers--including Henkel AG & Co. KGaA (A/Stable/A-1), Procter & Gamble Co. (AA-/Stable/A-1+), Reckitt Benckiser Group PLC (A+/Stable/A-1)--that represent nearly 80% of its sales. However, this is tempered by our view of Zobele's solid position in the growing niche market of air care and insecticide devices, its track record of innovation, and its long-standing relationship with the large household and personal care players.
The proposed transaction includes a EUR180 million bond whose proceeds will be used to repay all outstanding bank debt, an undrawn EUR30 million RCF, and the conversion of the full shareholder loan into equity. We understand that none of the instruments will carry maintenance covenants. Bullet maturities and lack of maintenance covenants will improve the group's liquidity into "adequate" territory after the transaction. Moreover, we calculate that adjusted leverage will decline to about 5x after the proposed transaction. Sustained leverage below 5x could lead to an improvement of the financial profile to "aggressive."
Our base-case scenario over the next two years includes the following assumptions:
-- Mid-single-digit organic growth in revenues. This reflects our opinion that Zobele will continue to grow its operations with its existing customer base, which we expect to increase by 2%-4%. The growth forecast also reflects our opinion that Zobele should be able to win new contracts as the trend toward outsourcing and cost reduction continues for household and personal care players like Reckitt Benckiser and Procter & Gamble.
-- Limited improvement in profitability. This reflects our expectation of higher sales and therefore improved operating leverage, and increasing contribution from the higher-margin insecticide business as Zobele develops this activity in emerging markets. But we think the company's negative country mix might offset some of these improvements--large household and personal care players tend to have weaker profitability in emerging markets than in mature markets, which we believe may ultimately harm Zobele's margins.
-- Capital expenditure (capex) of about EUR15 million, in line with previous years.
-- No dividend payment.
-- Limited merger and acquisition activity.
Under the current structure, we view Zobele's liquidity as "less-than-adequate."
We project that sources of cash will exceed uses of cash by 1.2x in 2013. However, we have assessed liquidity as less than adequate because of upcoming maturities in 2014 and 2015--EUR22 million of term loan A and EUR24 million of the currently drawn RCF will mature in December 2014, and EUR55 million of term loan B and EUR55 million of term loan C will mature in 2015. Zobele had EUR11 million of cash on balance sheet at year-end 2011, and we project limited--below EUR10 million--annual free cash flow generation under the current capital structure.
Under the current capital structure, our assessment of the group's liquidity as less than adequate includes our projection of a likely breach of covenants over the next 12 months if the proposed refinancing is not completed successfully.
We believe the group's liquidity will improve to adequate on completion of the proposed transaction. We expect Zobele to have EUR26 million in cash on balance sheet after the transaction based on Sept. 30, 2012, figures, EUR30 million under the long-term undrawn RCF, break-even free cash flow, and no debt maturities until the bond matures in 2018-2020.
The recovery prospects for the proposed bond reflect our view that the company would be reorganized as a going concern in the event of a default due to its international presence and value-added relationship with fast moving consumer goods companies. However we believe that recovery prospects for bondholders are limited because of the amount of debt facilities ranking ahead, and our view of the Italian insolvency regime as less favorable for secured lenders. While the proposed bond is senior secured, we believe the security package provided for bondholders is fairly weak, comprising pledges over shares, receivables, and some moveable assets.
Our simulated default scenario assumes a default in 2016 primarily due to a loss of a key customer, leaving manufacturing capacity unutilized, increased competition, and reduced margins. We believe this would be compounded by global fast moving consumer goods companies attempting to reduce costs in a weaker macroeconomic environment, with a negative impact on Zobele's margins and an inability for the company to pass through raw material price increases, leading to a payment default in 2016. At our hypothetical point of default we envisage EBITDA to have reduced to around EUR26 million. We envisage a stressed enterprise value of about EUR130 million at the point of hypothetical default, equivalent to 5.0x the assumed stressed EBITDA multiple. We deduct priority liabilities, mainly enforcement costs and factoring lines. We then deduct EUR31 million for the super senior RCF. This leaves around EUR70 million for the senior secured bond, resulting in average (30%-50%) recovery prospects for bondholders.
The positive CreditWatch implications reflect the likely enhancement of Zobele's liquidity profile and financial risk profile upon successful completion of the proposed transaction. We could raise the corporate credit rating to 'B' and assign a positive outlook if the transaction was completed under the preliminary terms that we have reviewed, including the amount and maturity of the bond and RCF, the lack of maintenance covenants in the new capital structure, and the conversion of the shareholder loan in its entirety into equity.
We expect to resolve the CreditWatch placement on completion of the proposed transaction, or, if the transaction is delayed, over the next three months.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
New Rating; CreditWatch/Outlook Action
Corporate Credit Rating B-/Watch Pos/--
Zobele Holding S.p.A.
Senior Secured EUR180 mil bnds* B
Recovery Rating 4
*Guaranteed by Zobele Group